Hard Lessons in Modern Lending

After the financial crisis, banks had to reduce risk. For business owners, the process has been a difficult education in the current-day workings of financing.

Photograph by Greg Miller

The Printer: In 2008, David Moyal’s bank agreed to provide financing for a $3.8 million state-of-the-art printing press. A year later, after the press had been assembled and shipped, the bank pulled out.

Photograph by Greg Miller

THE DIE CUTTERFor five years, Joe Bliss never missed a loan payment. But after revenue at his business took a hit in 2009, Bliss’s bank cut his lines of credit – part of a nationwide retrenchment that affected borrowers deemed noncore.

THE MANUFACTURERS Demand at Stam is finally increasing. In the past, CEO Kent Marvin (right) would have sought to expand. But Stam, which was dropped by its bank in 2009, plans to sit on this recovery. “Heaven forbid there’s another recession,”says CFO Brendan Anderson(left).Photography by Greg Miller

Joe Bliss thought the worst was over. Revenue at JBC Technologies–a Cleveland-based die cutter that makes products as diverse as materials used in electronics and small components for automobiles–had plunged 40 percent when the recession hit. Bliss had dismissed half of his 96 employees, cut wages across the board, and slashed his own salary to almost nothing.

Now, in the summer of 2010, sales were finally back. Bliss had restored his employees’ salaries, repaid lost wages, and begun hiring again. He also resumed planning the expansion he had envisioned for the company–which included 40,000 square feet of additional manufacturing space and new corporate offices.

Then, on August 17, the men from Charter One bank came to visit.

Bliss, who had been banking with Charter One for five years, had $6 million worth of commercial loans outstanding. He says he never missed a payment or, as far as he knew, violated any of the covenants, the financial metrics that banks mandate to ensure the health of their borrowers. But the Charter One reps told him the bank wanted the 22-year-old company’s loans off its balance sheet, part of a retrenchment that would affect billions of dollars’ worth of loans in the bank’s commercial portfolio.

It didn’t matter that JBC’s business had recovered; the decision had been made months before. The men recognized the irony. Under different circumstances, “we’d be aggressively pursuing you as a customer,” one of them told Bliss. But JBC had been deemed, in the oblique vocabulary of Charter One and its parent companies, Citizens Bank and the Royal Bank of Scotland, noncore.

The problem was not Bliss’s company but his industry and region–both of which, in an effort to stem future losses, his bank had essentially written off. Charter One, like other banks across the country, was using a sort of predictive math to sever ties with struggling borrowers before they stopped making payments. In the process, banks were abandoning businesses that were recovering, too. “It was a bizarre situation,” Bliss says. “We were successful. It was so frustrating.”

Charter One’s divorce from Joe Bliss was just a tiny part of a precipitous pullback by the banking industry. From 2008 to 2010, the volume of business loans dropped some 22 percent. In cash terms, commercial lending experienced a $325 billion decline over those two years; the volume of small-business loans (generally defined as loans of less than $1 million) fell by $26 billion, and then kept falling: By June 2012, small-business loans were down $56 billion from their June 2008 peak of $336.4 billion.

Of course, it helps to remember what banks were going through at the time. Once the financial crisis was in motion, banks faced tremendous pressures. Government regulators introduced capital requirements that compelled banks to reduce their exposure to risk–mandates that often meant shifting more risk onto the borrower in the form of larger down payments, more collateral, and more onerous personal guarantees. Given that banks have watched hundreds of their peers struggle with insolvency, it’s not surprising that banks began enforcing their covenants more strictly than they had in years.

Lending is finally beginning to crawl back, though the emphasis should be put on crawl–the stats would qualify as bad news if the past few years hadn’t been so grim. Most banks are no longer tightening credit standards for small businesses, according to the Federal Reserve. And the volume of small-­business loans fell just 1 percent from June 2011 to June 2012, compared with an 8.5 percent drop during the corresponding period 12 months earlier. Part of the reason for the slow recovery is that businesses remain too spooked to borrow. “Demand is down,” says Jordan Peterson, senior vice president for business banking at PNC Financial Services Group. “We’re seeing small businesses deleveraging, taking cash to pay down debt. But we’re anxious to lend money.”

Still, many entrepreneurs remain more than a little traumatized. “We’re terrified of what a bank will do now,” says Lowell Jaeger, owner of Jaeger Lumber, a Union, New Jersey-based chain of seven lumberyards. In 2011, after the chain posted its first annual loss in more than four decades, PNC abruptly canceled its $4 million line of credit–despite the fact that Jaeger Lumber expected to be back in the black and had banked with PNC for about 20 years. Jaeger managed to get credit from TD Bank. Still, he has been shaken up. In the past, his inclination was to pounce on an economic recovery, acquiring distressed competitors and upgrading facilities. Not this time. “I’m not going to take a chance on expanding and have another bank pull out,” he says.

For anyone with a stake in the U.S. economy, that’s the last thing you want to hear. Although the financial crisis was (one hopes) a once-in-a-generation disaster, there will always be business downturns. And in a dynamic economy, some industries will inevitably end up on the wrong side of new technology or shifting consumer tastes. But the latest crisis made clear that the era of personal banking is over–indeed, that it had been for years. The scale of modern banking has made the relationship between banks and small businesses more remote, more mathematical, and less personal. In the next downturn, you can’t assume that a warm relationship with your loan officer will protect you.

It’s also clear that as the economy recovers, entrepreneurs and banks will need one another again. The question business owners should be asking isn’t whether the system will go back to the old ways–it won’t–but whether they have taken the right steps to protect themselves and borrow prudently in this new world.